Speculator

Article byPeter Johnson
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Speculator Meaning

A speculator is an individual or financial institution that places short-term bets on securities based on speculations. Rather than focusing on the long-term growth prospects of a particular company, they would take calculated risks on a stock with the potential of yielding a higher return. They place stop-loss orders or position sizing to ensure they do not incur heavy losses.

With a deep understanding of financial markets, a financial speculator often takes the form of a venture capitalist or hedge fund. In other words, they are experts who understand their markets in detail and factor into market research and technical analysis to understand the movement of an asset price in one direction or the other.

Key Takeaways

  • Speculators are individuals (or institutions) that practice short-term bets on assets with the expectation of generating a profit.
  • Instead of looking for a company’s long-term prospects, they are more concerned with the stock’s ability to experience a significant price rise in a short period.
  • Different speculative traders, including market makers and private equity firms, utilize different trading strategies to buy securities and benefit from price changes.
  • They play an essential role by adding liquidity to the financial markets, making it easier to buy and sell when needed. However, uncontrolled speculator activity can lead to a speculative bubble or market crash.

How Do Speculators Work?

Speculators are individuals or investment firms who make constant attempts at predicting the movement of a particular asset and make exorbitant gains from these speculations. They are often confused or mischaracterized as gamblers. However, it is far from the truth. Financial speculators use their expertise to find the right instrument before taking a risky call.

The main reason behind people putting their money into securities is to make long-term or short-term profits. Financial markets feature investors and traders with the same goals – to make a profit and avoid losing money. While some individuals focus more on the “make a profit” aspect, others adopt the “avoid losing money” approach. It is also a well-known fact in the trading community that long-term investmentsLong-term InvestmentsLong Term Investments are financial instruments such as stocks, bonds, cash, or real estate assets that a company intends to hold for more than 365 days in order to maximize profits and are reported on the asset side of the balance sheet under the heading non-current assets.read more tend to be less risky than those made for the short-term.

Speculators tend to fall on the “make a profit” end. The speculation style of trading generally involves taking on more risk than other types of individuals in the financial marketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more, such as investors. The additional risk comes from trading assets that are considered volatile, or in other words, stocks that are prone to making dramatic price changes. However, one can also speculate on non-volatile assets that other investors have not discovered yet.

They can maximize their returns by using leverage or borrowing money to expand their position. But using a leverage strategy while speculating can lead to significant losses. For example, Bill Hwang, who managed the private investment firm Archegos Capital Management, lost $10 billion by speculating on ViacomCBS (VIAC) stocks and building his position with various risky financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more.

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Types

There are several different groups that a financial speculator can be categorized into. Let us discuss the most prominent ones through the points below.

Speculator

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Source: Speculator (wallstreetmojo.com)

#1 – Bulls

Individuals classified as bulls expect the asset price to increase in value. Therefore, they will purchase an asset to sell it back for a higher price later. Bulls remain optimistic about the asset’s price, believing it will be worth more when they sell it, and if it is, they make a profit.

#2 – Bears

Bears are the opposite of bulls when it comes to speculation in the financial markets. They expect the asset price to decrease in value and bet on their decline. Bears will profit when short sellingShort SellingShort sale of stocks also known as shorting is a process of selling the borrowed stocks. Trader borrows the security from the broker and then sells it in the open market and thereafter, buys the security back at an appropriate time to pay it back to the broker.read more an asset, such as stock, and repurchasing it at a lower price later.

Fun Fact: Bulls and bears in the financial markets get their name from how they strike. Bulls strike up (bullish), and bears strike down (bearish).

#3 – Lame Duck

Lame-duck speculator finds themselves in a situation that is not what they expected. These traders suffer unexpected losses due to a lack of devising an effective trading strategy. Typically, the term is used to describe a bear incapable of meeting its end of the deal but can also apply to bulls.

#4 – Stag

Stags are different speculators that expect to profit from very short-term price changes in new company stocks. As a result, stags will often be more careful regarding risk and profit than others on this list. Instead, they speculate on capturing profits as the asset demand increases, increasing its value.

Impact

To be a speculator requires a lot of research and expertise, or what is referred to as doing due diligence. It is vital to know the risks involved with the asset and the potential reward. Another essential aspect of speculation is the timing of the trade. The timing is crucial because, as a speculative trader, one expects a dramatic change in price in a short amount of time.

People often associate them with gamblers. However, the difference between the two groups of individuals is that a market speculator will take calculated risks to make sure they are best positioned to make a profit. In contrast, a gambler would just hope for a return.

Bring Liquidity

One of the most critical factors for any financial market is the availability of liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more, or the ability to buy and sell with ease. As a result, they can add liquidity to markets that are not as popular among investors, such as commoditiesCommoditiesA commodity refers to a good convertible into another product or service of more value through trade and commerce activities. It serves as an input or raw material for the manufacturing and production units.read more or the foreign exchange (Forex) market. For example, speculative traders increased their net short positioningShort PositioningA short position is a practice where the investors sell stocks that they don't own at the time of selling; the investors do so by borrowing the shares from some other investors to promise that the former will return the stocks to the latter on a later date.read more on the US dollar on February 26, 2021, according to data released by the Reuters and Commodity Futures Trading Commission.

When a well-known market speculator like Jesse Livermore or Michael Burry enters a speculative position, others will often follow, increasing demand and driving the value up.

Help Control Price Volatility

When a stock has a dramatic price change in either direction, a speculative trader will sometimes enter a position with the expectation of the price reversing. This behavior can help control assets with high volatility and influence the price to find a medianMedianThe median formula in statistics is used to determine the middle number in a data set that is arranged in ascending order. Median ={(n+1)/2}thread more. However, it can also work the opposite way, where speculative traders will pile into security, causing the asset to become more volatile.

Speculator vs Investor

They often get classified as investors, but these two groups of individuals have several differences such as their investing styles, and perspectives. Moreover, the trading an investor executed and the style of speculator trading are quite different. Let us understand the differences through the discussion below.

Speculator

  • Often takes on additional risks.
  • Speculates for short-term price changes to make a profit
  • Strives for high returns in a short period
  • Is not necessarily concerned with the long-term growth potential of an asset
  • Is in the financial markets to trade assets

Investor

  • Can take on risks, but typically less than a speculative trader
  • Holds assets for a more extended period, getting a better possibility of generating a return
  • Looks for growth over the long term to create a profit
  • Hopes for incremental returns over some time
  • Is very concerned with the long-term growth potential of a company
  • Is in the financial markets to invest in companies

Also, you may want to look at Investment vs SpeculationInvestment Vs SpeculationInvestment is when a security or an asset is purchased to hold for a long-term period anticipating that it will gradually increase in value over time. In contrast, speculation is a more risk-based transaction where the sole purpose is to make a single short-term profit.read more for an in-depth understanding of these concepts.

This has been a guide to Speculator & its meaning. Here we explain their types, compare them with investors, and put forth their impact on the market. You may also have a look at the following articles to learn more –